The U.S. office market vacancy rate reached 15.9 percent in the second quarter, the highest level in four years, and rent fell by the largest amount in more than seven years as demand remained weak, according to a leading real estate research firm.
It's bad, Reis Inc director of research Victor Calanog said. It's decaying and getting worse. Given the depth and magnitude of the recession, you can argue that we are facing a storm of epic proportions and we're only at the beginning.
The average weighted U.S. office vacancy rate rose by 0.70 percentage point during the quarter and by 2.7 percentage points compared with a year earlier, according to a Reis report released on Tuesday.
Asking rent during the quarter fell 1.4 percent to $28.43 per square foot. Factoring in rent-free months and improvement costs to landlords, effective rent -- the net amount of cash landlords take in -- fell 2.7 percent to $23.42 per square foot. The second-quarter drop was more severe than the first quarter's 2.3 percent, dampening hopes the office market is bottoming out, Reis said.
Year over year, rent was down 6.7 percent, the largest one-quarter decline since the first quarter of 2002.
This is really only the third quarter that we've experienced negative effective rent growth, Calanog said. Last time, the office sector had four years of negative effective rent growth.
Although the sector has experienced downturns before, the current one may be lethal for investors who bought property during the boom years 2005-2007. In many cases, property prices and loans were based on the belief that occupancy rates would continue to rise and rents would continue to post strong growth.
It's like taking on a lot of debt as an individual and now suddenly earning 10 percent, 20 percent, 30 percent less, Calanog said.
The dwindling cash flow resulting from higher vacancy and lower rent weakens the ability to repay financing and pushes a borrower closer to defaulting on a loan.
The weak second-quarter performance prompted Reis to maintain its February forecast calling for the U.S. office vacancy rate to top out at 18.2 percent in 2010 and for rent to continue to fall through 2011. It also sees the commercial real estate default rate reaching 4.2 percent by year-end, and peaking at 5.2 percent in 2011.
The U.S. vacancy rate was 12.5 percent in the third quarter of 2007 and has risen 3.4 percentage points since then, Reis said.
Of the 79 markets that Reis tracks, vacancy rose in 65 and effective rent fell in 72, indicating the weakness is widespread.
Vacancy in the New York area, which includes all the New York City boroughs except Staten Island, rose 1.2 percentage points to 10.8 percent, the highest level since 1996, and effective rent slid 5.2 percent
As far as we can tell for New York, the next two years will be murder, Calanog said.
Boston and Orange County and San Jose, California, saw rent fall more than 5 percent.
Those results do not bode well for office landlords SL Green Realty Corp
In early trade, shares of SL Green, the largest owner of Midtown Manhattan office buildings, were off nearly 5 percent, or $1.07, at $20.72. Brookfield shares were down 2 percent, or 15 cents, at $7.26. Maguire shares were down 2.5 percent, or 2 cents, at 79 cents.
Boston Properties shares fell 2.6 percent, or $1.23, at $45.54. Vornado was down 3.4 percent, or $1.48, at $42.29.
During the second quarter, office space coming on the market topped rented space by about 20 million square feet, slightly less than the 25.2 million square feet in the first quarter.
Year-to-date, 45.2 million more square feet came onto the market than was rented, in line with Reis' projection of about 67.6 million square feet for all of 2009.
If the projection holds true, 2009 will be the worst year for net absorption of office space since Reis began tracking it in 1980.
(Reporting by Ilaina Jonas; editing by Andre Grenon and John Wallace)